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Pension-led business funding: controlled risk, increased cashflow

FINANCIAL DECISION makers within SMEs appear unaware of a source of business funding that could put them back in control of their financing, while reducing loan risk: pension-led funding.

With pension-led business funding the financing comes directly through the owners’ pension funds. Based on current pension valuations, this could inject £100bn or more back into the UK’s SME economy.

The value of IP
One specific area of pension-led business funding leverages the value of intellectual property (IP) held by the company. This is one of the most valuable, but least exploited, assets of most businesses. It is a little known fact that the vast majority of business assets reside in IP, which includes patents, trademarks, brands and even website domains.

When it comes to asset value, in 2010 the World Bank estimated that royalty and licence fees alone generated £5.25bn in the UK. In April 2012, a government report from the UK’s Intellectual Property Office opened with the statement: “Achieving strong, sustainable and balanced economic growth is the government’s economic policy priority and IP is an increasingly important means of supporting growth.”

Yet according to research carried out by Clifton Asset Management, financial decision rarely value IP at any more than 10% of business worth with the majority seeing no value in it at all. Equally, only 17% of respondents felt IP was a suitable asset for a director’s pension to buy while almost half were unsure or did not know its suitability.

How does it work?
Initiating IP-led pension-based funding requires detailed assessment of company accounts, track record, business plan and funding structure to determine the IP value. However, it is essential the valuation is entirely independent of the funding process to satisfy HMRC and protect the pension fund and its trustees.

There are three main IP valuation approaches: cost, market and income. Cost examines investment in IP already made by the company and how much remains valid. The market approach looks at prices paid for similar IP by other companies, while income focuses on potential future value of the IP.

Once an IP valuation is received, the pension fund can agree to purchase and leaseback some, or all, of the IP value from the business and the funding is facilitated by the pension specialist.

Once the cash transfer has been implemented, there is usually a straightforward monthly lease payment between the business and the pension fund, which is a tax deductible item.

Putting the control back in business
What frustrates so many directors is knowing the quality of their business but, even in the light of recent government initiatives, they are unable to convince lenders whose own interests often come before the business they are funding. Traditional lenders may be quick to demand their money back if climate dictates and will usually require personal guarantees or a charge over a personal asset such as a director’s home.

While not an either/or option, pension-led business funding changes the balance because it is funding by the directors for the directors and no right-minded business owner is likely to pull the rug from under their own, successful business.

The pension risk
Running a business has to involve some general elements of risk. However, pension-led business funding is a controlled, rather than uncontrolled risk. The pension scheme is protected from external creditors (and is therefore a valuable business asset), although it is itself often a creditor to the business so, in the event of the company defaulting, the pension scheme may suffer a loss. This is, however, almost always smaller than the sum of money initially paid for the IP by the pension fund, as IP lease payments would have been paid back to the pension fund by the business, since the funding arrangement was put in place.

In the extremely rare circumstances that the lease agreement has to be written-off entirely, the only cost is the money (minus the lease payments to date) that has already been paid into the business. Set this against traditional, third party funding methods where not only would directors be liable to pay back the borrowing, often immediately, but may be forced to realise this through the assets used to secure that borrowing – in some cases a family home.

Adam Tavener is chairman of Clifton Asset Management

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